Published: 17 May 2024
Contributor: Alexandra Jonker
A power purchase agreement (PPA) is a long-term contract between energy buyers (offtakers) and energy suppliers. PPAs define the price that an energy supplier will receive for every megawatt-hour (MWh) of energy generated from a renewable energy asset. They also outline the amount of electricity to be supplied, the length of the agreement and details such as transmission issues and insurance.
PPAs provide energy buyers with greater control over their energy consumption habits, significant energy cost savings and, in some cases, cost certainty. They can also grant the buyer with the asset’s associated renewable energy certificates (RECs). RECs represent the electricity that could have otherwise been generated by fossil fuels. Organizations use RECs to support their clean energy and sustainability goals and comply with carbon emissions regulations. Similar energy attribute certificates exist in the European Union (EU) called Guarantees of Origin (GOs).
For energy suppliers, PPAs provide long-term cash flow certainty. They are considered key to the further development of renewable energy projects such as solar and wind farms.
Power purchase agreements are either onsite or offsite. Here are the major differences:
In an onsite power purchase agreement, the renewable energy assets, such as wind turbines or solar panels, are installed at the offtaker's location. The energy supplier (or project developer) handles the operations, ownership and maintenance of the renewable energy system for the agreed-upon term. There are generally no upfront or capital costs for the energy buyer.
For some energy buyers (mainly large organizations) onsite renewable energy generation may not be adequate for meeting renewable energy goals. Offsite PPAs allow them to meet these goals and even fulfill regulatory obligations by providing access to large-scale renewable energy installations from which they can procure larger volumes of renewable energy.
Power purchase agreements are either physical or financial. Physical PPAs are characterized by physical delivery of electricity to the customer through the grid. Financial PPAs—also called virtual PPAs, synthetic PPAs, contract for differences, or fixed-for-floating swaps—provide energy buyers with financial credits or offsets for the renewable energy generated, but the energy supplier sells the electricity to the grid. The revenue from this sale (based on the agreed-upon “strike price” per kilowatt-hour) is returned to the energy buyer. If the sale of electricity is below the agreed-upon strike price, the customer owes the seller the difference. Financial PPAs are considered a hedging arrangement, as they reduce the risk of electricity price volatility for both parties.
Financial PPAs are particularly useful for organizations in traditionally regulated energy markets that do not allow physical PPAs. Financial PPAs allow such organizations to take advantage of tax credits and incentives and meet sustainability goals. They also provide the energy sellers funding for project development.1
There are several PPA pricing models on the market:
A fixed-price or fixed-rate PPA gives buyers a set price for electricity purchases. These PPAs offer price stability against electricity market fluctuations. For organizations, this can translate to greater operational predictability. Fixed-price PPAs are among the most common PPAs on the market.
Also called variable or floating PPAs, index-based PPAs are priced, based on current market rates for electricity. Like fixed-price PPAs, they are also very common. These types of PPAs offer greater flexibility than fixed-price PPAs, but also introduce the risk of market volatility. However, variable PPAs still deliver electricity at a discount-to-market price.
Less common than fixed-price and index-based PPAs, hybrid-price PPAs mix and match electricity pricing models: some power is delivered at a fixed price, some is delivered at a variable price. This is a more complex agreement but can help energy buyers reap the benefits of both energy price predictability and flexibility.
PPA price models may also include annual escalators or price escalation rates. In these instances, electricity is sold to the buyer at a price that increases at certain intervals during the contract at an agreed-upon rate.
Green tariff PPAs are offered by utility companies and give energy buyers an alternative to traditional PPAs. Through a green tariff PPA, a utility buys electricity from renewable energy generators and power plants on behalf of an energy buyer. The buyer receives both the energy and associated RECs. This is a voluntary utility program that can help energy customers advance and fund renewable energy development and meet their sustainability goals without directly managing a PPA.
The combination of stakeholder pressure, increased awareness of environmental issues caused by the effects of climate change and the potential financial benefits of renewable energy have made PPAs attractive to corporate buyers across sectors. Multinational organizations in technology (who use corporate PPAs to meet data center electricity demand), retail and manufacturing are among some of the top purchasers. In 2023, Amazon—the top renewable energy buyer of that year—announced 74 PPAs across 16 markets totaling 8.8 gigawatts.
Nonprofit organizations also buy PPAs. Since these organizations cannot take advantage of federal tax credits to support the purchase of onsite renewable energy systems, PPAs are a viable green energy procurement option.
Individual homeowners can also enter into PPAs. For example, solar power purchase agreements (SPPA) allow individuals to host solar projects, such as a photovoltaic (PV) system with solar panels, on their property with no upfront costs. Like traditional PPAs, solar PPAs allow the developer to own and operate the energy system from which the host customer can purchase the electricity.
Blockchain technology has it made it possible to split large PPA contracts into smaller units, both in units of energy and length of time. This has created a secondary market for PPAs with lower barriers to entry for smaller companies and individual buyers.
Currently, the Americas, which includes the US, Canada and Latin America, is the largest region for PPA activity. This region is followed by the European, Middle Eastern and African (EMEA) region. Comparatively, PPA activity is significantly lower in the Asia Pacific (APAC) region but has seen record highs with recent policies supporting growth.2
PPAs offer energy cost savings, energy cost stability and the ability to support the advancement of the renewable energy transition. However, there are some challenges associated with PPAs:
PPAs are lengthy and complex contractual agreements. Signing and negotiating this type of contract can be costly and may even require additional advice from outside accounting firms.
Due to the intermittent nature of renewable energy sources (solar panels require sunlight to create solar energy and wind turbines require wind to spin), some organizations that enter into a PPA might also need energy storage systems to prepare for and manage energy shortages.
For organizations, measuring the impact of renewable energy procurement (through PPAs, RECs and more) can be particularly complex. Some choose to adopt technology to help, like data management and reporting platforms that also support audit requirements.
Improve your asset management strategy and optimize asset performance with a full suite of applications for operations, and health, safety and environment (HSE) tools for the utilities and energy industry.
Predict energy demand with accurate forecasting and plan for vegetation growth near power lines.
Capture and track your renewable energy certificates and support market-based emissions reporting with greenhouse gas (GHG) emissions management software from IBM Envizi™.
Renewable energy is energy generated from natural sources that are replenished faster than they are used.
RECs certify that the bearer owns one MWh of zero-carbon electricity that has been generated by renewable energy sources and delivered to the power grid.
Sustainability is the long-term ambition for people to coexist on Earth without depleting its natural resources.
Solar power, also known as solar energy, is a renewable energy source that uses particles of sunlight (photons) for energy production.
Wind power is a type of renewable energy that harnesses the kinetic power of wind for electricity generation.
Energy storage is the capturing and holding of energy in reserve for later use.
Footnotes
1 "Financial PPA" (link resides outside ibm.com). United States Environmental Protection Agency, 1 November 2023.
2 "Amazon Is Top Green Energy Buyer in a Market Dominated by US" (link resides outside ibm.com). BloombergNEF, 26 February 2024.